Inflation cooling and a collapse in oil prices dismantle the rate-hike consensus; internal ECB opinions are split, and September may become a policy watershed.

There is no longer a unified view within the European Central Bank on whether to continue tightening policy. The rapid decline in oil prices and cooling inflation in the eurozone are reducing the urgency for further rate hikes, prompting the market to reassess the interest rate outlook for the year.

According to Bloomberg, ECB officials at the annual forum in Sintra, Portugal, showed clear divisions over whether further rate hikes are needed to bring inflation back to the 2% target. Some officials believe that the inflationary pressures triggered by the conflict are still being transmitted and may manifest later through wages, food, and service prices.

Other officials argue that as peace efforts make progress, oil prices have fallen back to pre-war levels, and severe second-round inflation effects may not occur. The sharp decline in eurozone inflation in June also supports this assessment.

The market generally expects the probability of a major policy adjustment at the July meeting to be very low, and standing pat has become the market consensus. However, as more wage data is released before the September meeting, the likelihood of a widening divergence will increase significantly.

Dovish Camp: Limited Risk of Second-Round Effects, Data Supports Cooling Inflation Thesis

Several officials have publicly expressed views that inflation risks are easing. Finnish central bank governor Olli Rehn said in an interview that he does not expect any significant second-round effects, implying limited support for further rate hikes.

Austrian central bank governor Martin Kocher said in another interview that the inflation threat "has clearly diminished, at least in the short term."

Governing Council members from Slovenia and Latvia, Primoz Dolenc and Martins Kazaks, both said there is no need for action in July; Belgian central bank governor Pierre Wunsch hinted that there may not even be a reason to raise rates again.

The eurozone's June inflation rate was 2.8%, a clear slowdown from May's 3.2% and below the median expectation of 3% from economists surveyed by Bloomberg. Core inflation, which excludes volatile items like food and energy, and the closely watched services inflation indicator also eased.

This change is largely due to oil prices falling to pre-war levels and being significantly lower than the assumptions used in the ECB's forecasts last month. According to those forecasts, inflation would remain above the 2% target until 2027.

Hawkish Camp: Beware of Inflation Rebound

At the same time, the hawkish camp, led by Lane, remains cautious. As a key figure who proposes policy recommendations to Governing Council colleagues, Lane stressed that officials are committed to "not locking themselves" onto a fixed rate path.

German central bank governor Joachim Nagel echoed this statement, although he acknowledged that the drop in oil prices was "indeed unexpected."

Estonian central bank governor Ulo Kaasik said in an interview that he considers at least one more rate hike "reasonable," while Greek central bank governor Yannis Stournaras said in another interview that, under current circumstances, "it might be better to hold steady for a while." These two statements are seen as representing the two poles of the current division.

ECB President Lagarde: Risks Have Become More Balanced

ECB President Christine Lagarde acknowledged in the closing panel discussion at the Sintra Forum that the situation has changed rapidly recently. The discussion also featured Federal Reserve Chair Jerome Powell.

She said that given the rapid recent developments, the upside risks to inflation and the downside risks to growth "may be more balanced than they were a few weeks ago."

Wage Data is a Variable, September Meeting Could Be a Key Juncture

Analysts believe that although the current inflationary pressures have eased, due to the long lag in the release of wage data, the market still needs to wait for clearer evidence. If the previous period of faster inflation has already fueled demands for higher wages, price pressures could become more entrenched and persist for longer.

Simona Delle Chiaie, eurozone chief economist at Bloomberg Economics, said that the improving economic outlook may widen the divisions within the Governing Council, as the urgency for further rate hikes is diminishing. She noted that although the baseline forecast still includes one more rate hike this year, the downside risks to that forecast are becoming more pronounced.

As more economic data is released before the September meeting, the debate within the ECB over the rate hike path is expected to intensify, making it a key observation window for the eurozone's monetary policy direction in the second half of the year.

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